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ESG — environmental, social and governance — has become a central concern for some of the world’s largest companies, and that trend will only accelerate.
“Most large corporations have placed an increased emphasis on an ESG strategy for 2022 and beyond,” said Tania Dunham, C2FO’s vice president for channel sales. “New scrutiny by the investment community, consumers and employees has driven broader acknowledgement that businesses will be held accountable for their environmental and social impact.”
Historically, a company’s performance was judged almost solely through its annual financial reports, but that’s changing, said Colin Sharp, senior vice president for international at C2FO.
“ESG is becoming the second measure for the performance of the business, and it’s more aligned with not just shareholder value, but stakeholder value, including employees, customers, partners and so on,” Sharp said.
Those standards have a real-world impact because customers won’t buy from companies with bad reputations. And the best employees won’t work for them.
How are companies applying this new reality to their operations? Here are five trends that C2FO’s team has noticed in our conversations with decision-makers around the world.
Companies that ignore sustainability could find it harder to access capital at competitive terms. According to Gartner, ESG is taken into consideration by 91% of banks, 71% of fixed-income investors, over 90% of insurers and 24 global credit rating agencies.
As a result, having a poor track record on sustainability could lead to higher costs for financing.
Sharp remembers a recent call with a CFO.
“His thing was, ‘Help me understand what I need to do to get compliance on ESG because the capital markets will start to freeze up for me,’” Sharp recalled. “Because a lot of capital markets now are offering green bonds, green funding, and it’s cheaper. If I can’t present my ESG credentials, I can’t get access to cheap funding.”
The growth of ESG-focused investment funds is another factor.
“ESG has become an increasingly important topic for Mexican companies, partly because of greater interest among investors and regulators,” said Jeronimo Osio, C2FO’s managing director for Mexico.
Last year, for example, saw the launch of the S&P/BMV Total Mexico ESG Index, an investment vehicle that excludes companies with poor ESG track records. And in 2022, the government required pension funds to consider ESG issues as part of their investment strategies.
Many companies have already adopted socially and environmentally responsible practices inside their organizations.
But there’s been a growing realization that many companies’ impact is much larger because of the products and materials they source from their suppliers, which might not be following the new standards.
“Depending on the industry, anywhere from 70% to 90% of potential ESG impact is in the supply chain, not within the four walls of the company,” Sharp said.
And so companies are asking their suppliers to adopt best practices, too. As a result of pressure from multinational buyers, companies around the world are taking ESG more seriously. If a German company changes its policies, it could lead to suppliers in India and Kenya rethinking how they operate.
That’s a good outcome, though in practice, there are usually a few problems, Sharp said.
For starters, solar panels don’t grow on trees. Suppliers don’t always have the money to fund a series of environmentally friendly upgrades.
And they don’t always have time to fill out the forms that buyers — and in a lot of cases, multiple buyers — are asking for. In fact, if the self-reporting or self-auditing burden is too heavy, that just encourages suppliers to lie and report they’re compliant when they aren’t.
A growing number of companies are no longer treating E (environmental) and S (social) issues as two separate things.
“There is a recognition that environmental and social challenges are related, resulting in an overlapping of efforts and linked outcomes,” Dunham said. “For example, human rights and workplace safety are directly impacted by an organization’s environmental policies.”
Historically, the United States has put greater emphasis on diversity and inclusion, while Europe devoted more attention to environmental impact, but that’s changed, Sharp said. Now, the two regions are converging somewhat.
In the US, for example, the Biden administration has voiced greater support for robust climate policies. And more European companies are focusing on inclusion because they’ve lost out on opportunities with the US government. Those companies haven’t been able to document how they support diverse businesses — which, in many cases, is a precondition for doing business with Uncle Sam.
“It’s having a revenue impact on their ability to win business,” Sharp said, “because they’re saying, ‘Look, you can’t provide any figures on the number of diverse businesses that you’re supporting, so you don’t make the grade.’”
Companies can only measure their ESG progress if they have clear data about what’s occurring at different points in their supply chain.
That’s why some companies are starting to invest in data-sharing platforms that make reporting easier for everyone involved, no matter how big or small their organization is.
In Europe, one of the most exciting examples is Open-es, a digital platform for sharing information on the sustainability of production chains, Sharp said. It’s from Eni, the Italian energy company, in partnership with Boston Consulting Group and Google Cloud.
Open-es is one place where all kinds of companies, from small to mid-sized enterprises (SMEs) to large corporations, can share best practices. It’s also a huge win for small suppliers, which ideally will only have to upload their ESG metrics to one portal, which reduces their reporting burden. Best of all, it’s free.
It’s good that larger companies are leading the way here, said Ravi Tanniru, C2FO’s senior vice president for India. Micro, small and medium enterprises (MSMEs) are more focused, by necessity, on simply staying in business. Even companies that are interested in ESG tend to focus on making their own operations more ESG-compliant first.
“Larger companies are in a better position to think about the entire supply chain and how businesses can work together to encourage sustainable growth,” Tanniru said. “These bigger companies are leading the way by encouraging this shift in thought.”
It’s not enough for large companies to tell their suppliers to follow a new set of rules and ask for more reporting. To spur real change, enterprises need to financially support ESG-friendly updates.
“Rather than beating up your suppliers constantly to conform, offer them a benefit for doing so,” Sharp said.
One way is by providing preferred payment terms, like the dynamic discounting option available through C2FO’s platform. Suppliers that meet the buyer’s ESG standards can qualify for accelerated payment in exchange for giving a small discount.
Some enterprises structure their ESG incentives on a gold-silver-bronze scale to reward the progress that suppliers make toward compliance, Sharp said. Suppliers with a silver rating might qualify for funding that takes 50 basis points off the cost of financing through the enterprise, while a gold supplier could get 100 basis points off.
Although it’s important for buyers and suppliers to collaborate, companies should remember to encourage their internal teams to cooperate and look for ways they can work together to advance the organization’s sustainability goals.
For example, Sharp said, the treasury department can help create incentives that support ESG goals, but only if procurement helps it understand what will move the needle for suppliers.
Companies of all sizes are putting a greater emphasis on ESG strategy because a range of stakeholders have put them under greater scrutiny. One area where businesses can have the greatest impact is the supply chain — for example, by offering preferred payment terms to ESG-conscious suppliers and making it easier to share reporting data and best practices.
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